Monday, May 10, 2010


Euro Rescue Bid
Punish the Markets for their Mistakes!
A Guest Commentary by Michael Hüther

The DAX of leading German shares also made a recovery on Monday.
Europe has put up 750 billion euros in an effort to stop speculation against the European common currency. Still, it remains to be seen if financial markets will learn their lesson. After all, speculators aren't even being punished for the damage they have caused. But they should be.

At least €750 billion! This weekend, Europe's politicians came up with an unprecedented rescue package in their bid to gain the upper hand on the financial markets. In the language of the capital markets: The politicians are once again ahead of the curve. The partly euphoric reaction on the markets also speaks in favor of a turnaround. The euro even rose strongly against the dollar.

Was this massive rescue action necessary? That question is difficult to answer. There is no way of assessing the value of any alternatives -- or to let the rescue package for Greece have an effect first. However, we know from previous crises that simply running after the markets brings little success. One has to succeed in surprising them and in rapping the protagonists on the knuckles. That is exactly what the European Union can finally do now. If the euro climbs in value in the coming days, then many speculators will have to react and end their bets on it to ensure that they don't end up losers themselves.

Under the postulate that politicians had to act now, the finance ministers of the 27 EU states gave out the right signal late into Sunday night: They erected one of the biggest stop signs for speculation ever build. The European Commission and the member states are making €500 billion ($641 billion) available in loan guarantees to struggling countries, augmented by at least €250 billion ($320 billion) from the International Monetary Fund (IMF). This sum is designed to calm the markets and end the speculation against the euro.

An Important Omission

However, there is also the danger of a significant false incentive. Economically weak countries with high budget deficits and large mountains of debts could see the rescue package as an invitation to ask for help from their partners in the case of an emergency.

That is why it is important that the IMF be involved. Its tough rules on cleaning up state finances are the preconditions for any possible aid to Spain, Portugal and Co. Tougher sanctions within the euro zone against those who break the rules will thus be possible. That is an important step.

Nevertheless, the EU finance ministers have made one important omission: They should have consistently tied in the creditors of the state debts. The involvement of the creditors -- for example writing off part of the loans -- is necessary to strengthen the risk awareness on the financial markets.

The Greek crisis has shown once again how unrealistic it is to assume that the capital markets will immediately answer aberrations with higher risk premiums. In the first eight years following Greece's entry into the euro zone, risk premiums for the state bonds actually sank to such a low level that the purchase of Greek bonds must have seemed almost risk-free.

It was only after the Greek government admitted last autumn that there were massive budget problems that the markets reacted with increased risk premiums. It was because they had been caught napping themselves that the creditors now have to be shown that they too carry a responsibility for the disaster. If they don't see that they also made mistakes, then they could end up believing that they will always be let off the hook. The fact that the creditors to Greece and other problem countries are not being made take part in cleaning up the budget problems is the central failure in this rescue package.

Euro Zone Could Still Fall Apart

It is also of concern that the European Central Bank (ECB) is to buy government bonds from deficit countries. That weakens the bank's credibility. After all, it is not just the financial markets but also many citizens who worry about whether the euro can remain stable in the face of all the member states' huge debts. The lesson from history, that governments like to use inflation as an escape route, makes many deeply wary. In that regard, any attack on the ECB's independence is fatal.

Whether the rescue package will protect the euro from collapsing in the long term depends on how seriously the deficit countries are about consolidating their budgets. If discipline is lacking, despite the IMF oversight, then the currency union could still break apart.

Countries like Germany that had a strong currency before the euro could then feel forced to leave the euro zone and push forward with a smaller and stronger currency union. That, however, looks far less likely after this weekend's events. Greece, Spain and Portugal have now agreed to make even more of an effort to clean up their public finances.

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